nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2022‒01‒31
ten papers chosen by

  1. Welfare Implication of Tax Rates Increase in a Recessionary Economy By Ibrahim, Umar Bambale; Abubakar, Isah Funtua
  2. Introducing an Austrian Backpack in Spain By Julian Diaz Saavedra; Ramon Marimon; Joao Brogueira de Sousa
  3. Why does risk matter more in recessions than in expansions? By Martin M. Andreasen; Giovanni Caggiano; Efrem Castelnuovo; Giovanni Pellegrino
  4. Consumer Credit with Over-Optimistic Borrowers By Florian Exler; Igor Livshits; James MacGee; Michele Tertilt
  5. Monetary Policy and Endogenous Financial Crises By Frederic Boissay; Fabrice Collard; Jordi Galí; Cristina Manea
  6. Financial Frictions, Firm Dynamics and the Aggregate Economy: Insights from Richer Productivity Processes By Ruiz-García, J. C.
  7. The Euro Area's Pandemic Recession: A DSGE-Based Interpretation By Roberta Cardani; Olga Croitorov; Massimo Giovannini; Philipp Pfeiffer; Marco Ratto; Lukas Vogel
  8. Premature deaths, accidental bequests and fairness By Marc Fleurbaey; Marie-Louise Leroux; Pierre Pestieau; Gregory Ponthiere; Stéphane Zuber
  9. Firm Inattention and the Efficacy of Monetary Policy: A Text-Based Approach By Wenting Song; Samuel Stern
  10. Mitigating climate change: Growth-friendly policies to achieve net zero emissions by 2050 By Florence Jaumotte; Weifeng Liu; Warwick J. McKibbin

  1. By: Ibrahim, Umar Bambale; Abubakar, Isah Funtua
    Abstract: In this work, we compare the welfare cost of the two tax policy options in Nigeria, by applying a small-open economy within the New-Keynesian Dynamic Stochastic General Equilibrium Model (NKDSGE) of Nigeria augmented by a robust fiscal sector with several tax rules. Increase in tax rates has different welfare implications in a recessive economy. Increase in Consumption tax VAT rate is welfare superior compared to increase in CIT rate, which harms private agents’ incentive to invest in either new or existing venture. Hence, data does not support tax reform in the form of increase in Company Income Tax rate. Our finding implies that the current Nigerian tax reform in the form of an increase in VAT rate while allowing other tax rates unchanged is the right policy direction.
    Keywords: DSGE Models; Fiscal Policy; Welfare
    JEL: H24
    Date: 2020–09–30
  2. By: Julian Diaz Saavedra (Department of Economic Theory and Economic History, University of Granada.); Ramon Marimon (European University Institute, UPF - Barcelona GSE, CEPR and NBER.); Joao Brogueira de Sousa (Nova School of Business and Economics.)
    Abstract: In an overlapping generations economy with incomplete insurance markets, the introduction of an employment fund – akin to the one introduced in Austria in 2003, also known as ‘Austrian backpack’– can enhance production efficiency and social welfare. It complements the two classical systems of public insurance: pay-as-you-go (PAYG) pensions and unemployment insurance (UI).We show this in a calibrated dynamic general equilibrium model with heterogeneous agents of the Spanish economy in 2018. A ‘backpack’ (BP) employment fund is an individual (across jobs) transferable fund, which earns the economy interest rate as a return and is financed with a payroll tax (a BP tax). The worker can use the fund when becomes unemployed or retires. In Spain, as an open economy, to complement the existing PAYG pension and UI systems with a welfare maximising 6% BP tax would raise welfare by 0.96% of average consumption at the new steady state, and would be preferred to the status quo by most economic and demographic groups. We also analyze, as a reference, Spain as a closed economy. There are important general equilibrium effects and, as a result, the social value of introducing the backpack is substantially greater; 16.14%, with a BP tax of 18%. Our model also provides a framework where to study reforms of existing social protection systems supported by the introduction of the BP.
    Keywords: Computable general equilibrium, welfare state, social security reform, retirement.
    JEL: C68 H55 J26
    Date: 2021–12–04
  3. By: Martin M. Andreasen; Giovanni Caggiano; Efrem Castelnuovo; Giovanni Pellegrino
    Abstract: This paper uses a nonlinear vector autoregression and a non-recursive identification strategy to show that an equal-sized uncertainty shock generates a larger contraction in real activity when growth is low (as in recessions) than when growth is high (as in expansions). An estimated New Keynesian model with recursive preferences and approximated to third order around its risky steady state replicates these state-dependent responses. The key mechanism behind this result is that firms display a stronger upward nominal pricing bias in recessions than in expansions, because recessions imply higher inflation volatility and higher marginal utility of consumption than expansions.
    Keywords: New Keynesian Model, Nonlinear SVAR, Non-recursive identification, State-dependent uncertainty shock, Risky steady state
    Date: 2021–09
  4. By: Florian Exler; Igor Livshits; James MacGee; Michele Tertilt
    Abstract: Do cognitive biases call for regulation to limit the use of credit? We incorporate over-optimistic and rational borrowers into an incomplete markets model with consumer bankruptcy. Over-optimists face worse income risk but incorrectly believe they are rational. Thus, both types behave identically. Lenders price loans forming beliefs—type scores—about borrower types. This gives rise to a tractable theory of type scoring. As lenders cannot screen types, borrowers are partially pooled. Over-optimists face cross subsidized interest rates but make financial mistakes: borrowing too much and defaulting too late. The induced welfare losses outweigh gains from cross subsidization. We calibrate the model to the U.S. and quantitatively evaluate policies to address these frictions: financial literacy education, reducing default cost, increasing borrowing costs, and debt limits. While some policies lower debt and filings, only financial literacy education eliminates over borrowing and improves welfare. Score-dependent borrowing limits can reduce financial mistakes but lower welfare.
    Keywords: Consumer Credit; Over-Optimism; Financial Mistakes; Bankruptcy; Default; Financial Literacy; Financial Regulation; Type Score; Cross-Subsidization
    JEL: E21 E49 G18 K35
    Date: 2021–12–07
  5. By: Frederic Boissay; Fabrice Collard; Jordi Galí; Cristina Manea
    Abstract: We study whether a central bank should deviate from its objective of price stability to promote financial stability. We tackle this question within a textbook New Keynesian model augmented with capital accumulation and microfounded endogenous financial crises. We compare several interest rate rules, under which the central bank responds more or less forcefully to inflation and aggregate output. Our main findings are threefold. First, monetary policy affects the probability of a crisis both in the short run (through aggregate demand) and in the medium run (through savings and capital accumulation). Second, a central bank can both reduce the probability of a crisis and increase welfare by departing from strict inflation targeting and responding systematically to fluctuations in output. Third, financial crises may occur after a long period of unexpectedly loose monetary policy as the central bank abruptly reverses course.
    JEL: E32 E44 E52
    Date: 2021–12
  6. By: Ruiz-García, J. C.
    Abstract: How do financial frictions affect firm dynamics, allocation of resources across firms, and aggregate productivity and output? Is the nature of productivity shocks that firms face primary for the effects of financial frictions? I first use a comprehensive dataset of Spanish firms from 1999 to 2014 to estimate non-parametrically the firm productivity dynamics. I find that the productivity process is non-linear, as persistence and shock variability depend on past productivity, and productivity shocks are non-Gaussian. These dynamics differ from the ones implied by a standard AR(1) process, commonly used in the firm dynamics literature. I then build a model of firm dynamics with financial frictions in which productivity shocks are non-linear and non-Gaussian. The model is consistent with a host of evidence on firm dynamics, financial frictions, and firms’ financial behaviour. In the model economy, financial frictions affect the firm life cycle. Without financial frictions, the size of an entrant firm will be three times larger. Furthermore, profit accumulation, which allows firms to overcome financial frictions, is slow, and it only speeds up when firms are mature. As a consequence, the average exiting firm is smaller than it would be without financial frictions. The aggregate consequences of financial frictions are significant. They result in misallocation of capital and reduce aggregate productivity by 16%. This figure is only 8% if productivity dynamics evolve according to a standard AR(1) process.
    Keywords: Firm Dynamics, Non-Linear Productivity Process, Financial Frictions, Misallocation
    JEL: E22 G32 O16
    Date: 2021–08–03
  7. By: Roberta Cardani; Olga Croitorov; Massimo Giovannini; Philipp Pfeiffer; Marco Ratto; Lukas Vogel
    Abstract: The COVID-19 pandemic led to a sharp contraction of economic activity in the euro area (and worldwide). Its anatomy differs strongly from other crises in recent history. We analyse the short-term economic effects of the COVID-19 shock through the lens of an estimated DSGE model. We augment the canonical DSGE set-up with “forced savings" (lockdowns, social distancing), labour hoarding (short-time work) and liquidity-constrained firms to capture salient demand and supply effects of the COVID shock and the containment and stabilisation policies. Shock decompositions with the estimated model show the dominant role of “lockdown shocks" (“forced savings", labour hoarding) in explaining the quarterly pattern of real GDP growth in 2020, complemented by a negative contribution from foreign and investment demand particularly in 2020q2 and a negative impact of persistently higher (precautionary) savings. The initial inflation response has been modest compared to the severity of the recession.
    JEL: C11 E1 E20
    Date: 2021–12
  8. By: Marc Fleurbaey (PSE - Paris School of Economics - ENPC - École des Ponts ParisTech - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique - EHESS - École des hautes études en sciences sociales - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement); Marie-Louise Leroux (ESG-UQAM - UQAM - Université du Québec à Montréal = University of Québec in Montréal); Pierre Pestieau (Université de Liège); Gregory Ponthiere (UCL - Université Catholique de Louvain = Catholic University of Louvain); Stéphane Zuber (PSE - Paris School of Economics - ENPC - École des Ponts ParisTech - ENS Paris - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique - EHESS - École des hautes études en sciences sociales - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)
    Abstract: While little agreement exists regarding the taxation of bequests in general, there is a widely held view that accidental bequests should be subjected to a confiscatory tax. We reexamine the optimal taxation of accidental bequests by introducing a concern for compensating individuals for a premature death. Assuming that individuals care about what they leave to their offspring, we show that, whereas the 100 % tax view holds under the utilitarian criterion, the ex post egalitarian criterion (giving priority to the worst-off ex post) implies subsidizing accidental bequests so as to compensate the short-lived. In a second-best setting, compensating the short-lived justifies taxing total bequests at a rate increasing with the age of the deceased. Finally, when the model is extended to an intergenerational setting, accidental bequests cannot be used as a redistributive tool anymore, so that ex post egalitarianism rejoins the 100 % tax view.
    Keywords: mortality,accidental bequests,optimal taxation,compensation,OLG models
    Date: 2021
  9. By: Wenting Song; Samuel Stern
    Abstract: This paper provides direct evidence of the importance of firm attention to macro-economic dynamics. We construct a text-based measure of firm attention to macro-economic news and document firm attention that is polarized and countercyclical. Differences in attention lead to asymmetric responses to monetary policy: expansionary monetary shocks raise market values of attentive firms more than those of inattentive firms, and contractionary shocks lower values of attentive firms by less. We use the measure to calibrate a quantitative model of rationally inattentive firms with hetero-geneous costs of information. Less attentive firms adjust prices slowly in response to monetary innovations, which yields non-neutrality. As average attention varies over the business cycle, so does the efficacy of monetary policy.
    Keywords: Business fluctuations and cycles; Inflation and prices, Monetary policy
    JEL: D83 E44 E52
    Date: 2022–01
  10. By: Florence Jaumotte; Weifeng Liu; Warwick J. McKibbin
    Abstract: The paper examines climate mitigation strategies to reach net-zero emissions by mid-century, focusing on smoothing macroeconomic costs in the short- to medium-term - the horizon relevant for policymakers. It explores a comprehensive policy package, which complements carbon pricing with an initial green fiscal stimulus, consisting of green public investment and subsidies to renewables production. Model simulations show that thanks to the green public spending, the policy package boosts global output relative to the baseline for the first 15 years of the low-carbon transition. Subsequent transitional output costs resulting from further increases in carbon prices are moderate of the order of 1 percent of baseline global GDP by 2050. The findings suggest that upfront green fiscal packages could help smooth the transition to a low-carbon economy. In the current context of the Covid-19 economic crisis, they would help support the recovery from the crisis and put the global economy on a greener, more sustainable path.
    Keywords: Climate Change, Net-Zero Emissions, Green Infrastructure, Macroeconomics, DSGE, CGE, G-Cubed
    JEL: C51 C53 C54 C55 C68 F41 Q51 Q5
    Date: 2021–08

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